They believe that uncertainty about the direction of commodity prices and a perceived loss of budgetary discipline among euro-zone governments mean the European Central Bank’s 17-member governing council will ignore politicians’ calls for easier monetary policy when it meets in Frankfurt next Thursday (21 January).

Speaking after last week’s council meeting, ECB President Wim Duisenberg suggested that the coordinated 0.3-percentage-point cut in euro-zone interest rates to 3.0% at the beginning of December would be the last for some time.

“Effectively, there has been a considerable easing over the course of the past year, to the extent that the average three-month rate has … come down by slightly more than 100 basis points and one-third of that easing happened in December,” he said. “As far as we can see, there is no tendency which would force us to change interest rates in the future as far as we can foresee it.”

Nevertheless, Petra Köhler, a designated ECB-watcher at Dresdner Bank in Frankfurt, took his remarks as a sign that the bank will leave its key money-market intervention rate (the refinancing rate) at 3.0% throughout 1999. “It makes a lot of sense to wait for the impact of these interest rates to feed through,” she said. “A percentage-point reduction in rates is not insignificant.”

However, she is in a minority. Polls of economists carried out by financial news agencies reveal that most expect the bank to lop at least another 0.25 of a percentage point off the refinancing rate before the end of March as economic growth slows.

As the new year opened, one of Germany’s prestigious economic institutes, the Berlin-based DIW, cut back its forecast for the country’s growth rate to 1.4% – well below the government’s expectations of 2%.

Last week, it was announced that 34,000 Germans joined the ranks of the unemployed in December, raising the jobless rate to 10.9% of the total workforce. Since German output and money supply account for a third of the total in the euro area, indications of a slowdown in the Union’s economic locomotive are taken very seriously.

In France, the monthly survey published by statistical office INSEE revealed that a growing number of people believe unemployment will soon start rising again and are stashing away savings just in case.

It was a sharp downturn in business confidence which prompted the European System of Central Banks to cut interest rates in December. The European Commission’s monthly industrial indicator for the euro-11 area has shown a steady downturn since last summer, with a net 8% of companies expecting business conditions to worsen in November compared with 5% in October.

According to Michael Schubert, ECB analyst at Commerzbank, it will be this indicator above all which will cause the bank to opt for another cut in interest rates. “Industrial confidence will weaken further and there is no danger of inflation, so we think they will act before the end of the first quarter,” he said.

The ECB is mandated to keep annual euro-zone inflation below 2%. The latest figures from the EU’s statistical agency Eurostat show that inflation in the single-currency area slowed to a record low of 0.9% in November.

This has fuelled speculation that euroland could be starting to deflate – a process which becomes dangerous, as ECB chief economist Otmar Issing has pointed out, when people start to defer purchases on the prospect of further price cuts. But economists argue that such a deflationary spiral is not on the cards.

They point out that money supply is still growing at a healthy pace. The three-month average growth rate of M3 broad money – notes and coins in circulation plus easily-cashable deposits and savings instruments – was 4.8% in October. This is slightly above the 4.5% ‘reference’ growth rate the ECB has set itself for this year.

As they prepare their latest research for the governing council meeting next week, Issing’s staff are also uncertain about the direction of oil, metals, agricultural and forest product prices, which fell to 22-year lows during 1998. This has been one of the major reasons for low inflation in Europe.

However, influential US investment house Goldman Sachs is predicting a surge of as much as 20% in its commodity price index over the next 12 months. The bank believes that Russian oil exporters will be unable to keep up the pace of their sales, and this could remove a million barrels a day from the market within two months.

Goldman Sachs analysts are convinced that the effects of production cutbacks over the past 18 months are already beginning to push prices up throughout the markets for oil, forestry products and livestock.

Meanwhile, a huge question-mark hangs over the dollar as speculation grows over the sustainability of the US’ balance of payments position. Analysts expect the euro to strengthen against the dollar in the coming months, but nobody is ruling out a collapse in the exchange rate of the US currency and consequent downward pressure on import prices in euroland.

Add to this the inevitable problems arising from conducting a monetary experiment never attempted before on such a scale.

The ECB may have a harmonised measure for money supply growth and inflation, but they both lag behind developments in the real economy. Issing cannot be certain how interest rate changes will make themselves felt throughout the euro-zone credit markets, the ‘transmission process’ which is vital to monetary policy-makers.

It is against this background that the ECB is hesitating. Even Commerzbank’s Schubert, who anticipates a quarter-point cut in rates within three months, warns that anything more aggressive could pose inflationary dangers “not now but in 2000”.

Commerzbank economists have run a 0.5-point cut in rates through their model of the euroland economy and found that it would lead to faster inflation from the middle of this year. While growth would accelerate by 0.3% this year and 0.2% in 2000, a half-point rate cut would add 0.1 of a percentage point to inflation this year, 0.3 in 2000 and 0.5 in the subsequent two years.

Issing, a renowned anti-inflation ‘hawk’, will not want to take risks like that with other people’s money.

Main refinancing rate: 3.00% (confirmed 7 January)

Deposit rate: 2.75% (until 21 January)

Marginal lending rate: 3.25% (until 21 January)

ECB WATCH

Key dates in the bank’s calendar this month

18 January

European System of Central Banks (ESCB) invites bids for liquidity from banks in its weekly money market refinancing operation at 3% fixed rate

President Wim Duisenberg gives evidence to the European Parliament’s monetary subcommittee, Brussels (3pm)